Traditionally, investors thinking about retirement have invested in a mix of stocks and bonds designed to balance safety and growth. The closer to retirement or more risk-averse they are, the more of their portfolio they hold in bonds for safety and regular income. The system has even been institutionalized in the form of “target-date funds” that automatically put more of your holdings in bonds as you near retirement.
But today, more and more investors are questioning this model. Specifically, the interest rates of the last few years have forced many investors to rethink the bond portion of their portfolio.
Bonds just don’t fulfill the needs of retired investors any more: Interest rates are so low they don’t provide enough income to live off of, and most bonds will actually lose value over the next few years. Ten-year bonds issued recently have yields under 2%. Treasury Inflation-Protected Securities (TIPS) are actually being issued today at negative yields.
Not only are those interest payments too insignificant to fund your retirement, but once interest rates begin to increase (which they will, eventually) those low-yielding bonds will fall in value. Bonds that are being issued at just slightly below face value today will most likely be worth significantly less than face value in a few years.
Buying newly-issued bonds today would be foolish.
But it’s hard to throw an entire investment paradigm out the window. The fact is, though, it’s not the first time bond investors have had to adapt to a new paradigm. Thirty-two years ago, in 1981, 30-year Treasury bonds were being issued with yields of 15%. And previously-issued 30-year bonds were selling for huge discounts: a 30-year bond issued in 1970 that yielded 7.875% could be bought for 56% of face value in 1981.
Yet, investors thought bonds were a terrible investment. A bond trader quoted in The New York Times that year said, “Anyone who buys a bond today to hold for more than five years is out of his mind.”
The reason was high inflation and a 35-year bear market in bonds that had lasted from 1946 to 1981. At the time, investors thought inflation would remain in the double digits for the foreseeable future. The bond trader above and others quoted in the same New York Times article also expected inflation to continue to rise, making even the newly-issued 15%-interest-rate Treasury bonds a bad investment.
In retrospect, that seems like an insane assumption. But, as The New York Times financial columnist Floyd Norris wrote a little over a month ago, “A lot of people on Wall Street in 1981 could not remember a time when bonds were good investments.”
Of course, over the next 30 years, the bond market enjoyed a wonderful rally, and we now find ourselves in the opposite situation: everybody owns bonds, and yields are at rock bottom.
And unsurprisingly, Wall Streeters are now acting as if they can’t remember a time when bonds were bad investments. Or, as a Barclays banker quoted in Norris’ column said, “They say that fish don’t know that they live in water—until they are removed from it—and we wonder if some of the many market participants whose entire professional experience has been conditioned by the financial backdrop created by the bond market rally might underestimate some consequences of its termination.”
Luckily, you aren’t a fish. And hopefully, as a reader of Investment of the Week, you’ve had the courage to take control of your investments, and thus have the power to abandon this outdated paradigm now, before the aquarium-dwelling bankers come to the same realization.
Of course, abandoning low-yielding bonds is probably going to leave a pretty big hole in your retirement account. And you’re going to want to fill it with something safe and income generating.
One solution, which many retired or retiring investors have already embraced, is to craft a personalized combination of dividend-paying stocks. The hundreds of dividend-paying stocks traded on major exchanges makes it easy it tailor a portfolio to your risk tolerance and income needs. Just take a foundation of 2%- and 3%-yielding blue chips and dividend aristocrats, add some undervalued stocks with historically high yields or dividend-growers to boost your yield in the future, and then top off with a sprinkling of riskier but higher-yielding investments.
For the best ongoing advice on creating a portfolio of dividend-paying stocks, I have to recommend my own newsletter, the Dick Davis Dividend Digest. If you don’t have a subscription already, take a trial subscription today. Every month, you’ll get 30 new ideas. I highly recommend you try it.
Today’s stock recommendation comes from J. Royden Ward, Editor of Cabot Benjamin Graham Value Letter. The stock is Corning (GLW), which according to the Editor has a chance to advance from its current price to 24.40, a gain of 88% in two to three years.
Corning (GLW: Current Price 13.34) with headquarters in Corning, New York, was founded in 1851. The company evolved from an old-line housewares company, known formerly as Corning Glass Works, to a leading maker of liquid crystal display (LCD) panels, fiber optics and emission control equipment.
Corning is operating in several leading growth sectors: making glass for flat-screen TVs, smartphones, tablet computers and other electronic devices; manufacturing fiber optic equipment used by the telecommunications industry; and developing pollution control products to meet new emission standards.
After two years of declining profits, Corning is poised to increase sales and earnings. I expect sales to increase 6% and EPS to climb 14% during the next 12 months ending 3/31/14. New products, such as Gorilla Glass, an extra strong and clear glass, and ultra-thin Willow glass could easily push sales and earnings higher than expected. Fourth-quarter Gorilla Glass sales soared 68%. The innovative glass can now be found in one billion handheld and electronic devices worldwide.
GLW shares sell at a 10% discount to book value, sport a low current P/E of 10.9, and provide a dividend yield of 2.8%. The current P/E of 10.9 is well below GLW’s 10-year average P/E of 12.2. The company’s balance sheet is very strong with low debt and $4.15 per share in cash. GLW’s stock price will likely reach my Minimum Sell Price of 24.40 within one to two years. Corning is medium risk because sales and earnings are volatile.
Wishing you success in your investing and beyond,
Editor of Investment of the Week
P.S. You can find additional stocks selling at bargain prices in the new and improved Cabot Benjamin Graham Value Letter. Find out why our subscribers are showering Roy with compliments!
In every issue, you’ll find Roy’s legendary Maximum Buy and Minimum Sell Prices for over 250 well-known stocks.